Get With The Plan: July 13, 2014

Milo, 64, and Tasha, 60, spend well within their means and they live an enviable life without debt. While they’re close to the finish line, they’re worried about where their expenses will be in retirement and what that will mean to their bottom line.

“Our biggest financial concern is being able to maintain our current lifestyle after retirement with view of having to pay for supplemental medical, dental, vision and prescription insurance,” Milo says.

The couple, whose names have been changed, have saved $518,000 in 401(k) plans, $200,000 in IRAs, $3,300 in a brokerage account. $29,000 in a money market, $6,000 in savings and $3,000 in checking. Milo also will receive an annual pension benefit of nearly $30,000 unless he decides to take a lump sum payout.

The Star-Ledger asked John Zeltmann, a certified financial planner with RegentAtlantic Capital in Morristown, to help the couple decide when they can afford to retire.

“As with most pre-retirees, they wonder what health care costs will do to their nest egg,” Zeltmann said, noting they’re in a great position, but they still have to make smart choices so their financial future is solid.

The couple estimated a retirement budget of $56,000 a year, and those costs will be covered by Social Security and Milo’s pension. In fact, projections show a 99 percent chance that they will have assets left over at the end of their lives, which actuarial tables show will be age 90 for Milo and age 94 for Tasha.

And the couple can spend more.

“Milo and Tasha could afford to spend as much as $90,000 annually before their plan begins to enter lower confidence zones,” Zeltmann said. “The model I ran assumes an allocation of 60 percent equities and 40 percent fixed income, which projects an annual average return of 6.6 percent.”

The couple’s current portfolio is roughly in line with that recommendation, but it could use some tweaking.

Zeltmann says on the equity side, their portfolio is primarily invested in large- and mid-cap companies, with only a marginal allocation to small-cap companies. And on the fixed income side, they’re primarily in cash.

“Many folks look at cash as a safe haven,” Zeltmann says. “While it’s important to keep an emergency cash reserve on hand to cover six to nine months worth of living expenses, anything more than that is destined to lose purchasing power to inflation.”

For this couple, 34 percent is in cash, so Zeltmann says with rising interest rates on the horizon, he recommends they focus on shorter term, high quality debt and opportunistic bond funds, which generate return from credit risk instead interest rate movements. And even though inflation isn’t a significant threat today, Zeltmann says it will probably pick up in some fashion down the road, so it’s important to have inflation indexed bonds.

On the equity side, he suggests they add diversifiers such as emerging markets, international small-caps, domestic small-caps, frontier markets and infrastructure investments.

That brings us to Milo’s pension, which could give him $295,000 as a lump sum or $29,000 a year as an annuity.

Zeltmann says the debate has two parts to consider: the quantitative and the qualitative.

“It’s easy enough to break out a calculator and determine the assumed rate of return the plan administrator is using when calculating the annuity payment relative to the lump sum being offered — and from there, determining whether you can beat that rate of return in your portfolio,” he says.

But, it’s important to then layer in the qualitative components. Zeltmann says the pros to taking a lump sum include immediate access to your assets and knowing you can pass the assets along to your heirs — to the extent you don’t spend those dollars. The cons include the potential for poor investment returns and spending decision mistakes.

The annuity option offers guaranteed income for life and the elimination of investment pressures. The negatives include the fact that a pension benefit is not guaranteed by the employer and the monthly benefit will not be indexed for inflation. For example, if $4 of your monthly pension benefit buys a gallon of milk today, that same $4 will likely buy only a quart of milk 10 or 15 years from now, he says.

“If your employer goes out of business or if the company pension fund isn’t prudently managed, your benefit may be at risk,” he says. “The Pension Benefit Guaranty Corporation does offer some protection. In 2014, the maximum amount the PBGC will guaranty for a single 65-year-old retiree is $4,943.18 per month or $59,318.16 annually.”

In Milo’s case, Zeltmann says, all signs point to opting for the annuity.

Zeltmann says Milo needs to ask: “If I were to take the lump sum payment today, and assuming a given level of investment return, at what point would the annuity payout option catch up to my lump sum portfolio balance and where does that breakeven point stand relative to my life expectancy?”

For Milo, assuming a 7 percent return — which, after fees and taxes, is fairly aggressive — the breakeven point is between Milo’s ages 80 and 81.

Social Security benefits should also be considered, and Zeltmann recommends they consider what he calls a “Claim Now, Claim More Later” strategy.

When Milo turns 70, he’d start his benefits because they’d increase 8 percent a year from age 66. When Tasha turns 66, she’d file for her spousal benefits, and her own benefits would continue to increase at a rate of 8 percent a year until 70. At 70, she’d claim her own benefits.

This strategy would give them $282,000 more than if they each collected earlier.
Zeltmann also recommends the couple meet with an estate planning attorney to see what they can do to protect some of their assets from the New Jersey estate tax.